India

In this briefing:

1. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?
2. India Banks – HDFC Bank Subsidiary Stalled Profit
3. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion
4. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids
5. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details

1. India: Thermal Coal Imports Are Rising, What Does It Mean For End User Industries and the Economy?

India’s coal imports have risen 10% in the first eight months of FY19 and this year is likely to be the repeat of previous financial year when after falling for two years, India’s coal import had grown 8.1% yoy. After the NDA took over in May 2014, Indian Govt has spoken about eliminating coal imports altogether. However, there are serious problems with domestic production, logistics issues and poor track record of coal sector PSUs. Coal India Ltd (COAL IN) contributes more than 80% of India’s domestic coal output and FY19 has been a little better in comparison of previous years so far for the company. But, its performance has dipped over previous few months and it is very likely that coal imports will grow significantly again in FY19.

The higher coal imports is relevant for several sectors and many companies. The major implications are, 1) This is bad news for Coal India Ltd (COAL IN) and the company’s ability to increase supplies in the more profitable e-auction segment, 2) Increase in cost of power generation affects specific GENCOs and later, the entire power sector because cost of power procurement goes up for DISCOMs, 3) with increase in electricity prices, inflation may also increase and there is negative impact on balance between imports and exports, 4) it is also good news for renewables as they get more competitive on cost which makes them more attractive, 5) this is bad for entire value chain of coal based power plants which includes companies such as Bharat Heavy Electricals (BHEL IN).

2. India Banks – HDFC Bank Subsidiary Stalled Profit

When most analyze HDFC Bank (HDFCB IN), there is little emphasis on its non-banking finance company (NBFC) subsidiary, HDB Financial Services (HDBFS). Perhaps in the current environment, this is more important than ever. At the same time, where HDFC Bank’s subsidiary has had significant growth in recent periods, where this begins to change, it has important implications. Most do not believe HDFC Bank can ever show poor earnings growth, let alone high bad loans and credit costs. We disagree. As India’s second largest bank, it is  beholden to the macro economic overlay; even if delayed or not clearly visible. We wonder if HDBFS’s latest figures showing just 1% gross profit growth, is one sign of this?

3. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion

Metropolis Health Services Limited (MHL IN) (MHL) plans to raise US$100m+ in its Indian IPO. MHL is one of the largest diagnostic chains in the country. Carlyle invested in the company in 2015. 

MHL has registered steady growth and margins over the past few years. It has also aggressively expanded its network over the past few years, although revenue growth hasn’t matched the network expansion.

MHL’s recent financial performance has been in-line with its listed peers, Dr Lal Pathlabs (DLPL IN) and Thyrocare Technologies (THYROCAR IN), while the company continues to lead its two listed peers in terms of revenue generated per test.

4. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

Hitachi Ltd (6501 JP) announced the acquisition of an 80.1% stake in ABB Ltd (ABBN VX)’s power grids business for $6.4 billion. ABB will retain the remaining stake in the divested unit, which is valued at an EV of $11 billion. ABB’s power grids is a global #1 player and makes transformers, long distance electricity-transmission systems and energy storage units.

5. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details

It is universally acceptable that a significant and uncontrolled price rise especially for essential commodities is politically harmful for the incumbent Govt in a developing country like India. However, less than optimal price rise could also lead to justifiable anger in segment of population for which the livelihood is linked to it. While achieving this fine balance may not be an easy task for political establishment, we think these assumptions are just too simplistic. The political fortunes for the leaders and political parties are much more dependent on local, state specific factors and granular inflation data is a good measure of the price rise impact.

At the national level, the gap between rural and urban inflation is significant and in the latest data, inflation in urban areas is almost double of price rise in the rural areas. The consumer price inflation data says that there are regions which have negative increase in prices and there are many others which has inflation more than double of national average. In some extreme cases, the inflation gap between rural and urban areas in the same state is as much as 8%, higher than 3x of reported national average. Also from inter-state comparison, it is clear that this divergence becomes even more significant.

After the recent assembly elections, several explanations focused on rural distress and blamed agrarian crisis for BJP’s defeat. However, we can certainly draw more meaningful inferences from state level inflation data of these states. In Chhattisgarh, the difference between rural and urban inflation was huge (more than 6.5%) and this is more important in how the rural and urban population will be looking at the price rise. There are several other important data points from other states as well. But, it is clear that low inflation reflect poor prices the farmers may be receiving for their produce and in all these states where elections have taken place recently, inflation was less than average indicating higher distress levels. The differential between rural and urban inflation also implies inefficiency in the entire system and that affects political choices of masses.

In this briefing:

1. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside
2. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets
3. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread
4. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow
5. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

1. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside

• Multi Commodity Exch India (MCX IN) is the leading commodity futures exchange in India with ~90% market share. It enjoys ~100% market share in each of the top 7 products traded on its exchange.
• Average Daily Turnover (ADT) is up 24% YoY over YTD-Nov-18 after 4 years of stagnation on the back of increase in volatility of key commodity prices.
• We see 50-60% increase in ADT over FY18-21 on the back of Mutual Funds entering commodity futures trading creating enough liquidity for large industries like refineries shifting to MCX for hedging, bank distribution of commodity trading products and monetization of commodity options trading.
• MCX’s volumes are unlikely to be impacted by new entrants like NSE and BSE since none of the new entrants can offer any meaningful improvement over MCX’s offering in terms of lower cost, higher speed or tax friendliness. This makes MCX a ripe acquisition candidate going by global experience.
• We expect 16% Revenue Cagr, 20% EPS Cagr over FY18-21. Our target price for MCX at 28x Dec-20 EPS is Rs 950- implying 32% upside.

2. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets

• New industry data this week, plus take-aways from  our latest discussions with company managements, all confirm that the likely trend in the industrial segment of the global real estate industry is for rental rates to rise.
• The growth in e-commerce is continuing to accelerate globally. In some key market, this is “triggering a land grab for distribution space that experts say is accelerating”.
• Therefore, the increasing scarcity value of well situated industrial real estate in high demand markets is likely to continue to push up rental rates to higher and higher levels.
• Given our expectation that fundamentals driving the growing demand for Last Mile Industrial real estate are likely to persist, we continue to expect this segment to outperform the broader Real Estate sector for the foreseeable future.

3. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread

Repco Home Finance (REPCO IN) 2QFY19 results were in line with our estimates. The outstanding loan book portfolio reflected 11% YoY growth (v/s our expectation of 12%) at Rs 103,820 mn. The Net Interest Income (NII) was Rs 1,154 mn (v/s our estimates of Rs 1,230 mn), reflecting a YoY decline of 5%. The PAT was Rs 670 (v/s our estimates of Rs 618 mn), reflecting a YoY decline of 4%.

The management stated that the sand mining issue in Tamil Nadu (TN) (58.4% of outstanding loan book as of 1HFY19) lasted longer than expected. This has led to lower construction activity and demand for housing loans in Tamil Nadu. The company has guided for an improvement in 2HFY19 with the target of 15-16% loan growth.  They are focusing more on the other markets like Maharashtra, Gujarat, Karnataka to grow the loan book.

We have revised our NII estimates by -5.3%/-5.2%/ -1.5%, PPOP by -7.3%/-7.2%/-5.1% and PAT by -3.5%/ -3.5%/-1.9% for FY19E/FY20E/FY21E respectively.  We have revised our P/ABV multiple from 2.3x to 1.9x. Applying it to the adjusted book value for September-20E of Rs 306 per share, we arrive at the fair value of Rs 570 (earlier Rs 630)  for the next 12 months.

4. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow

• Mahindra & Mahindra (MM IN) reported 2QFY19 PAT of Rs 17,788 mn vs our estimate of Rs 15,240 mn. The revenues were 2.5% lower than estimated. EBITDA was Rs 18,493 mn as against our estimate of Rs 20,721 mn. EBITDA margins were  14.5% against our estimate of 15.8%.  Overall the performance was lower than our expectation.
• EBITDA margins were impacted due to higher raw material cost and higher launch cost related to Marazzo (7/8 seater utility vehicle). We expect the margins to remain under pressure for the 2HFY19E as the Company has lined up more new model launches.
• The shift in the festive season from 2Q to 3Q impacted the tractor sales volume in this quarter. M&M management expects the tractor industry to growth in the range of 12-14% YoY in FY19E where M&M is expected to grow at 12.5% YoY in FY19E.
• We have lowered EPS estimates for FY20E by 8%. Over FY18-21E, we expect revenue and PAT to grow at CAGR 14% and 13% respectively. We expect EBITDA margin to expand from 14.8% in FY18 to 15.5% in FY21E.
• Our EPS estimates for FY20E & 21E stand at Rs 47.3/- & Rs 53.7/- respectively. We have maintained the PE multiple of 17x with an EPS of Rs 47.2/- for the year ending September- 20E and valued its share in the subsidiaries at Rs 315/- to arrive at the fair value estimate of Rs 1,115/- for the next 12 months.

5. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

In this briefing:

1. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility
2. India Banks – The Roadmap Ahead
3. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC
4. Titan Co Ltd (TTAN IN)
5. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

1. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility

Last few months have been stressful for domestic fund managers and more than the sudden market movement, much increased volatility even in large caps has led to more anxiety for them. When we speak with some of the local fund managers, we get the sense that, a) the earnings season was mixed though revenue expectations were largely met for most companies and the worry was miss on profitability for some, b) there is still not high level of comfort on valuations and though correction came as a relief, the cash levels were not sufficient to take advantage of the situation, c) melt down in mid/small caps affect them less than big correction in large caps and that is why sharp movement in names like Tata Consultancy Svcs (TCS IN) , Infosys Ltd (INFO IN) and Maruti Suzuki India (MSIL IN) had hurt them much more, not to mention the volatility in Yes Bank Ltd (YES IN) and Sun Pharmaceutical Indus (SUNP IN) which had different kind of issues.

Most of them also think that some of the recent controversies such as RBI vs. Govt were completely avoidable and reflect political mismanagement than anything else. BJP’s loss in recent assembly elections is also negative but this was not completely unexpected because the margin is really small and things could have gone either way. In fact, some of them also say that the main Opposition party, Congress has not been able to completely exploit the failures of BJP Govt politically and appointment of RBI Governor is just like any other Govt official and media was unnecessarily and excessively focused on it, much more than what is warranted fundamentally speaking. However, silver lining for them is that some other market heavyweights such as Reliance Industries (RIL IN) and Hindustan Unilever (HUVR IN) have been steady.

While there is not much clarity on direction for the markets in next six months, the expectation is that volatility in local markets is likely to continue in 1H CY19 for three primary reasons, a) both crude and INR will continue to play a key role in market movement and expectation is that they will remain volatile, b) how the global macro factors such as trade war and relative attractiveness of EMs will play their role is not clear, c) the political factors and related news flow will drive the markets and though people still expect BJP may return next year (albeit in a coalition and with reduced mandate post 2019 Lok Sabha elections), the comfort levels have dwindled compared to how people were looking at it six to eight months ago. Among the specific sectors for the market, the interest levels are higher in FMCG and BFSI. People don’t expect IT to do badly but optimism has come down and Autos have also been a disappointment over last few months.

2. India Banks – The Roadmap Ahead

With the Reserve Bank of India (RBI) now effectively run by the government, there are likely to be discernable red flags ahead. We must expect that banks like State Bank Of India (SBIN IN) and others will overtly act as providers of liquidity. This will be both to struggling companies but also cash-strapped non-banking finance companies (NBFCs). In quarterly data this should show up in bank-specific figures, monetary numbers but also in corporate debt levels. It will be interesting to see if debt levels rise more for fragile indebted companies than others. Defaults should rise as well. This is because companies now realize that the government is running credit creation to support debtors, and will find it unjust to service a loan when others are not being penalized for default; at the margin they will choose not to pay. This goes to the well-known situation that occurred in Thailand after the 1997 crisis where the term was coined ‘can pay, won’t pay’ for these types of debtors.

3. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

Contrary to the perception that the rising adoption of socially responsible investment practices has caused Big Tobacco to be shunned by portfolio managers, our shareholding analysis shows that institutional holding in most of these ‘sin’ stocks has increased in the last 4 and 8 quarters.

Nevertheless, Big Tobacco suffered a pounding in 2018. Investors had bought into tobacco premising reduced risk products (Eg: e-cigarettes, Heat Not Burn products) would reduce regulatory risk and reverse decades of sales decline. As it turned out, regulators frowned at the popularity of vaping amongst teens in the US, calling out companies for baiting youngsters into long-term smoking habits. Regulators also told off companies for marketing e-cigarettes and HNBs as healthier options, as tobacco still kills.

Ethical portfolios with negative screens (for example, ones that will not invest in tobacco stocks) have underperformed in the long-term past. There is a growing tribe of funds committed to responsible investing with positive ESG screens. For such funds, we present in this insight a framework for analyzing the sector from an ESG perspective. A deep dive into ITC Ltd (ITC IN), the only cigarette major to turn in a positive performance this year, vindicates, in our view, its efforts to materially de-risk its asset and revenue profile, coupled with very high levels of commitment towards community development.

4. Titan Co Ltd (TTAN IN)

Titan Company Limited manufactures and sells watches, jewellery, eyewear, and other accessories and products in India and internationally. The company operates through four segments: Watches, Jewellery, Eyewear, and others. It is one of the few companies operating in organised jewellery retail industry of India. We visit stores & markets in Kochi (Kerela) and Chennai (Tamil Nadu), the biggest consumption markets to understand structural changes that have taken place in the industry, with an objective to tweak our revenue and margin estimates. We believe consensus might be underestimating growth from the jewellery segment which is the largest contributor with 81.60% of Sales as of FY2018. Our revenue estimates for FY19 and FY20 are 5.8% & 2.98% higher than consensus, primarily based on higher than expected market share gains from unorganised players. Our EBITDA margins for FY 19 & FY20 are 1% & 1.30% higher than consensus estimates primarily based on product mix which is in favour of studded jewellery and operating leverage as sales across stores pick up.  Our EPS for FY19 & FY20 is estimated at INR 18.60 and INR 24.26 per share which is higher than consensus by INR 2.47 and 4.05 per share for FY 19 and FY 20.  Based on an average forward multiple of 49x we arrive at a target price of INR 1187, representing a 30% potential return from current market price. 

5. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

The  results of the state assembly elections especially of Rajasthan, Madhya Pradesh and Chhattisgarh reveal the growing dissatisfaction of the electorate with the economic policies of the ruling Bharatiya Janata Party (BJP). BJP policies such as demonetisation (which was initially hailed as a brilliant decision) and the manner of implementation of the Goods and Services Tax (GST) dealt a severe blow to employment-intensive sectors like agriculture and the micro and small industries. The BJP had also allowed the agrarian sector in India to bear the burden of deflation, causing widespread peasant disenchantment, which became visible in massive farmer demonstrations culminating in the recent gathering in Delhi. Global investors should be prepared for significant increases in government expenditure on rural welfare schemes and farm income support to alleviate rural distress. In the absence of surpluses from the Reserve Bank, the government would have to expand the fiscal deficit for such schemes. If, on the other hand, the newly appointed RBI governor transfers the realized portion of the central bank surplus (the contingency reserve) to the government, such expenditure will weaken the central bank’s balance sheet at a time of global volatility. For the global investors the India risk has only increased.

In this briefing:

1. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion
2. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids
3. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details
4. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside
5. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets

1. Metropolis Healthcare Pre-IPO Quick Take – Steady Performance but Growth Lagged Network Expansion

Metropolis Health Services Limited (MHL IN) (MHL) plans to raise US$100m+ in its Indian IPO. MHL is one of the largest diagnostic chains in the country. Carlyle invested in the company in 2015. 

MHL has registered steady growth and margins over the past few years. It has also aggressively expanded its network over the past few years, although revenue growth hasn’t matched the network expansion.

MHL’s recent financial performance has been in-line with its listed peers, Dr Lal Pathlabs (DLPL IN) and Thyrocare Technologies (THYROCAR IN), while the company continues to lead its two listed peers in terms of revenue generated per test.

2. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

Hitachi Ltd (6501 JP) announced the acquisition of an 80.1% stake in ABB Ltd (ABBN VX)’s power grids business for $6.4 billion. ABB will retain the remaining stake in the divested unit, which is valued at an EV of $11 billion. ABB’s power grids is a global #1 player and makes transformers, long distance electricity-transmission systems and energy storage units.

3. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details

It is universally acceptable that a significant and uncontrolled price rise especially for essential commodities is politically harmful for the incumbent Govt in a developing country like India. However, less than optimal price rise could also lead to justifiable anger in segment of population for which the livelihood is linked to it. While achieving this fine balance may not be an easy task for political establishment, we think these assumptions are just too simplistic. The political fortunes for the leaders and political parties are much more dependent on local, state specific factors and granular inflation data is a good measure of the price rise impact.

At the national level, the gap between rural and urban inflation is significant and in the latest data, inflation in urban areas is almost double of price rise in the rural areas. The consumer price inflation data says that there are regions which have negative increase in prices and there are many others which has inflation more than double of national average. In some extreme cases, the inflation gap between rural and urban areas in the same state is as much as 8%, higher than 3x of reported national average. Also from inter-state comparison, it is clear that this divergence becomes even more significant.

After the recent assembly elections, several explanations focused on rural distress and blamed agrarian crisis for BJP’s defeat. However, we can certainly draw more meaningful inferences from state level inflation data of these states. In Chhattisgarh, the difference between rural and urban inflation was huge (more than 6.5%) and this is more important in how the rural and urban population will be looking at the price rise. There are several other important data points from other states as well. But, it is clear that low inflation reflect poor prices the farmers may be receiving for their produce and in all these states where elections have taken place recently, inflation was less than average indicating higher distress levels. The differential between rural and urban inflation also implies inefficiency in the entire system and that affects political choices of masses.

4. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside

• Multi Commodity Exch India (MCX IN) is the leading commodity futures exchange in India with ~90% market share. It enjoys ~100% market share in each of the top 7 products traded on its exchange.
• Average Daily Turnover (ADT) is up 24% YoY over YTD-Nov-18 after 4 years of stagnation on the back of increase in volatility of key commodity prices.
• We see 50-60% increase in ADT over FY18-21 on the back of Mutual Funds entering commodity futures trading creating enough liquidity for large industries like refineries shifting to MCX for hedging, bank distribution of commodity trading products and monetization of commodity options trading.
• MCX’s volumes are unlikely to be impacted by new entrants like NSE and BSE since none of the new entrants can offer any meaningful improvement over MCX’s offering in terms of lower cost, higher speed or tax friendliness. This makes MCX a ripe acquisition candidate going by global experience.
• We expect 16% Revenue Cagr, 20% EPS Cagr over FY18-21. Our target price for MCX at 28x Dec-20 EPS is Rs 950- implying 32% upside.

5. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets

• New industry data this week, plus take-aways from  our latest discussions with company managements, all confirm that the likely trend in the industrial segment of the global real estate industry is for rental rates to rise.
• The growth in e-commerce is continuing to accelerate globally. In some key market, this is “triggering a land grab for distribution space that experts say is accelerating”.
• Therefore, the increasing scarcity value of well situated industrial real estate in high demand markets is likely to continue to push up rental rates to higher and higher levels.
• Given our expectation that fundamentals driving the growing demand for Last Mile Industrial real estate are likely to persist, we continue to expect this segment to outperform the broader Real Estate sector for the foreseeable future.

In this briefing:

1. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread
2. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow
3. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much
4. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility
5. India Banks – The Roadmap Ahead

1. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread

Repco Home Finance (REPCO IN) 2QFY19 results were in line with our estimates. The outstanding loan book portfolio reflected 11% YoY growth (v/s our expectation of 12%) at Rs 103,820 mn. The Net Interest Income (NII) was Rs 1,154 mn (v/s our estimates of Rs 1,230 mn), reflecting a YoY decline of 5%. The PAT was Rs 670 (v/s our estimates of Rs 618 mn), reflecting a YoY decline of 4%.

The management stated that the sand mining issue in Tamil Nadu (TN) (58.4% of outstanding loan book as of 1HFY19) lasted longer than expected. This has led to lower construction activity and demand for housing loans in Tamil Nadu. The company has guided for an improvement in 2HFY19 with the target of 15-16% loan growth.  They are focusing more on the other markets like Maharashtra, Gujarat, Karnataka to grow the loan book.

We have revised our NII estimates by -5.3%/-5.2%/ -1.5%, PPOP by -7.3%/-7.2%/-5.1% and PAT by -3.5%/ -3.5%/-1.9% for FY19E/FY20E/FY21E respectively.  We have revised our P/ABV multiple from 2.3x to 1.9x. Applying it to the adjusted book value for September-20E of Rs 306 per share, we arrive at the fair value of Rs 570 (earlier Rs 630)  for the next 12 months.

2. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow

• Mahindra & Mahindra (MM IN) reported 2QFY19 PAT of Rs 17,788 mn vs our estimate of Rs 15,240 mn. The revenues were 2.5% lower than estimated. EBITDA was Rs 18,493 mn as against our estimate of Rs 20,721 mn. EBITDA margins were  14.5% against our estimate of 15.8%.  Overall the performance was lower than our expectation.
• EBITDA margins were impacted due to higher raw material cost and higher launch cost related to Marazzo (7/8 seater utility vehicle). We expect the margins to remain under pressure for the 2HFY19E as the Company has lined up more new model launches.
• The shift in the festive season from 2Q to 3Q impacted the tractor sales volume in this quarter. M&M management expects the tractor industry to growth in the range of 12-14% YoY in FY19E where M&M is expected to grow at 12.5% YoY in FY19E.
• We have lowered EPS estimates for FY20E by 8%. Over FY18-21E, we expect revenue and PAT to grow at CAGR 14% and 13% respectively. We expect EBITDA margin to expand from 14.8% in FY18 to 15.5% in FY21E.
• Our EPS estimates for FY20E & 21E stand at Rs 47.3/- & Rs 53.7/- respectively. We have maintained the PE multiple of 17x with an EPS of Rs 47.2/- for the year ending September- 20E and valued its share in the subsidiaries at Rs 315/- to arrive at the fair value estimate of Rs 1,115/- for the next 12 months.

3. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

4. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility

Last few months have been stressful for domestic fund managers and more than the sudden market movement, much increased volatility even in large caps has led to more anxiety for them. When we speak with some of the local fund managers, we get the sense that, a) the earnings season was mixed though revenue expectations were largely met for most companies and the worry was miss on profitability for some, b) there is still not high level of comfort on valuations and though correction came as a relief, the cash levels were not sufficient to take advantage of the situation, c) melt down in mid/small caps affect them less than big correction in large caps and that is why sharp movement in names like Tata Consultancy Svcs (TCS IN) , Infosys Ltd (INFO IN) and Maruti Suzuki India (MSIL IN) had hurt them much more, not to mention the volatility in Yes Bank Ltd (YES IN) and Sun Pharmaceutical Indus (SUNP IN) which had different kind of issues.

Most of them also think that some of the recent controversies such as RBI vs. Govt were completely avoidable and reflect political mismanagement than anything else. BJP’s loss in recent assembly elections is also negative but this was not completely unexpected because the margin is really small and things could have gone either way. In fact, some of them also say that the main Opposition party, Congress has not been able to completely exploit the failures of BJP Govt politically and appointment of RBI Governor is just like any other Govt official and media was unnecessarily and excessively focused on it, much more than what is warranted fundamentally speaking. However, silver lining for them is that some other market heavyweights such as Reliance Industries (RIL IN) and Hindustan Unilever (HUVR IN) have been steady.

While there is not much clarity on direction for the markets in next six months, the expectation is that volatility in local markets is likely to continue in 1H CY19 for three primary reasons, a) both crude and INR will continue to play a key role in market movement and expectation is that they will remain volatile, b) how the global macro factors such as trade war and relative attractiveness of EMs will play their role is not clear, c) the political factors and related news flow will drive the markets and though people still expect BJP may return next year (albeit in a coalition and with reduced mandate post 2019 Lok Sabha elections), the comfort levels have dwindled compared to how people were looking at it six to eight months ago. Among the specific sectors for the market, the interest levels are higher in FMCG and BFSI. People don’t expect IT to do badly but optimism has come down and Autos have also been a disappointment over last few months.

5. India Banks – The Roadmap Ahead

With the Reserve Bank of India (RBI) now effectively run by the government, there are likely to be discernable red flags ahead. We must expect that banks like State Bank Of India (SBIN IN) and others will overtly act as providers of liquidity. This will be both to struggling companies but also cash-strapped non-banking finance companies (NBFCs). In quarterly data this should show up in bank-specific figures, monetary numbers but also in corporate debt levels. It will be interesting to see if debt levels rise more for fragile indebted companies than others. Defaults should rise as well. This is because companies now realize that the government is running credit creation to support debtors, and will find it unjust to service a loan when others are not being penalized for default; at the margin they will choose not to pay. This goes to the well-known situation that occurred in Thailand after the 1997 crisis where the term was coined ‘can pay, won’t pay’ for these types of debtors.

In this briefing:

1. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC
2. Titan Co Ltd (TTAN IN)
3. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

1. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

Contrary to the perception that the rising adoption of socially responsible investment practices has caused Big Tobacco to be shunned by portfolio managers, our shareholding analysis shows that institutional holding in most of these ‘sin’ stocks has increased in the last 4 and 8 quarters.

Nevertheless, Big Tobacco suffered a pounding in 2018. Investors had bought into tobacco premising reduced risk products (Eg: e-cigarettes, Heat Not Burn products) would reduce regulatory risk and reverse decades of sales decline. As it turned out, regulators frowned at the popularity of vaping amongst teens in the US, calling out companies for baiting youngsters into long-term smoking habits. Regulators also told off companies for marketing e-cigarettes and HNBs as healthier options, as tobacco still kills.

Ethical portfolios with negative screens (for example, ones that will not invest in tobacco stocks) have underperformed in the long-term past. There is a growing tribe of funds committed to responsible investing with positive ESG screens. For such funds, we present in this insight a framework for analyzing the sector from an ESG perspective. A deep dive into ITC Ltd (ITC IN), the only cigarette major to turn in a positive performance this year, vindicates, in our view, its efforts to materially de-risk its asset and revenue profile, coupled with very high levels of commitment towards community development.

2. Titan Co Ltd (TTAN IN)

Titan Company Limited manufactures and sells watches, jewellery, eyewear, and other accessories and products in India and internationally. The company operates through four segments: Watches, Jewellery, Eyewear, and others. It is one of the few companies operating in organised jewellery retail industry of India. We visit stores & markets in Kochi (Kerela) and Chennai (Tamil Nadu), the biggest consumption markets to understand structural changes that have taken place in the industry, with an objective to tweak our revenue and margin estimates. We believe consensus might be underestimating growth from the jewellery segment which is the largest contributor with 81.60% of Sales as of FY2018. Our revenue estimates for FY19 and FY20 are 5.8% & 2.98% higher than consensus, primarily based on higher than expected market share gains from unorganised players. Our EBITDA margins for FY 19 & FY20 are 1% & 1.30% higher than consensus estimates primarily based on product mix which is in favour of studded jewellery and operating leverage as sales across stores pick up.  Our EPS for FY19 & FY20 is estimated at INR 18.60 and INR 24.26 per share which is higher than consensus by INR 2.47 and 4.05 per share for FY 19 and FY 20.  Based on an average forward multiple of 49x we arrive at a target price of INR 1187, representing a 30% potential return from current market price. 

3. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

The  results of the state assembly elections especially of Rajasthan, Madhya Pradesh and Chhattisgarh reveal the growing dissatisfaction of the electorate with the economic policies of the ruling Bharatiya Janata Party (BJP). BJP policies such as demonetisation (which was initially hailed as a brilliant decision) and the manner of implementation of the Goods and Services Tax (GST) dealt a severe blow to employment-intensive sectors like agriculture and the micro and small industries. The BJP had also allowed the agrarian sector in India to bear the burden of deflation, causing widespread peasant disenchantment, which became visible in massive farmer demonstrations culminating in the recent gathering in Delhi. Global investors should be prepared for significant increases in government expenditure on rural welfare schemes and farm income support to alleviate rural distress. In the absence of surpluses from the Reserve Bank, the government would have to expand the fiscal deficit for such schemes. If, on the other hand, the newly appointed RBI governor transfers the realized portion of the central bank surplus (the contingency reserve) to the government, such expenditure will weaken the central bank’s balance sheet at a time of global volatility. For the global investors the India risk has only increased.

In this briefing:

1. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids
2. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details
3. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside
4. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets
5. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread

1. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

Hitachi Ltd (6501 JP) announced the acquisition of an 80.1% stake in ABB Ltd (ABBN VX)’s power grids business for $6.4 billion. ABB will retain the remaining stake in the divested unit, which is valued at an EV of $11 billion. ABB’s power grids is a global #1 player and makes transformers, long distance electricity-transmission systems and energy storage units.

2. India: Divergence in State Level Inflation Data and Its Political Impact, The Devil Is in Details

It is universally acceptable that a significant and uncontrolled price rise especially for essential commodities is politically harmful for the incumbent Govt in a developing country like India. However, less than optimal price rise could also lead to justifiable anger in segment of population for which the livelihood is linked to it. While achieving this fine balance may not be an easy task for political establishment, we think these assumptions are just too simplistic. The political fortunes for the leaders and political parties are much more dependent on local, state specific factors and granular inflation data is a good measure of the price rise impact.

At the national level, the gap between rural and urban inflation is significant and in the latest data, inflation in urban areas is almost double of price rise in the rural areas. The consumer price inflation data says that there are regions which have negative increase in prices and there are many others which has inflation more than double of national average. In some extreme cases, the inflation gap between rural and urban areas in the same state is as much as 8%, higher than 3x of reported national average. Also from inter-state comparison, it is clear that this divergence becomes even more significant.

After the recent assembly elections, several explanations focused on rural distress and blamed agrarian crisis for BJP’s defeat. However, we can certainly draw more meaningful inferences from state level inflation data of these states. In Chhattisgarh, the difference between rural and urban inflation was huge (more than 6.5%) and this is more important in how the rural and urban population will be looking at the price rise. There are several other important data points from other states as well. But, it is clear that low inflation reflect poor prices the farmers may be receiving for their produce and in all these states where elections have taken place recently, inflation was less than average indicating higher distress levels. The differential between rural and urban inflation also implies inefficiency in the entire system and that affects political choices of masses.

3. MCX: The Pieces of the Puzzle Have Fallen in Place, BUY for 32% Upside

• Multi Commodity Exch India (MCX IN) is the leading commodity futures exchange in India with ~90% market share. It enjoys ~100% market share in each of the top 7 products traded on its exchange.
• Average Daily Turnover (ADT) is up 24% YoY over YTD-Nov-18 after 4 years of stagnation on the back of increase in volatility of key commodity prices.
• We see 50-60% increase in ADT over FY18-21 on the back of Mutual Funds entering commodity futures trading creating enough liquidity for large industries like refineries shifting to MCX for hedging, bank distribution of commodity trading products and monetization of commodity options trading.
• MCX’s volumes are unlikely to be impacted by new entrants like NSE and BSE since none of the new entrants can offer any meaningful improvement over MCX’s offering in terms of lower cost, higher speed or tax friendliness. This makes MCX a ripe acquisition candidate going by global experience.
• We expect 16% Revenue Cagr, 20% EPS Cagr over FY18-21. Our target price for MCX at 28x Dec-20 EPS is Rs 950- implying 32% upside.

4. Rental Rates for Last Mile Industrial Real Estate Poised to Move Higher in Most Key Global Markets

• New industry data this week, plus take-aways from  our latest discussions with company managements, all confirm that the likely trend in the industrial segment of the global real estate industry is for rental rates to rise.
• The growth in e-commerce is continuing to accelerate globally. In some key market, this is “triggering a land grab for distribution space that experts say is accelerating”.
• Therefore, the increasing scarcity value of well situated industrial real estate in high demand markets is likely to continue to push up rental rates to higher and higher levels.
• Given our expectation that fundamentals driving the growing demand for Last Mile Industrial real estate are likely to persist, we continue to expect this segment to outperform the broader Real Estate sector for the foreseeable future.

5. REPCO Home – 2QFY19 – Focus on LAP to Maintain the NIMs and Spread

Repco Home Finance (REPCO IN) 2QFY19 results were in line with our estimates. The outstanding loan book portfolio reflected 11% YoY growth (v/s our expectation of 12%) at Rs 103,820 mn. The Net Interest Income (NII) was Rs 1,154 mn (v/s our estimates of Rs 1,230 mn), reflecting a YoY decline of 5%. The PAT was Rs 670 (v/s our estimates of Rs 618 mn), reflecting a YoY decline of 4%.

The management stated that the sand mining issue in Tamil Nadu (TN) (58.4% of outstanding loan book as of 1HFY19) lasted longer than expected. This has led to lower construction activity and demand for housing loans in Tamil Nadu. The company has guided for an improvement in 2HFY19 with the target of 15-16% loan growth.  They are focusing more on the other markets like Maharashtra, Gujarat, Karnataka to grow the loan book.

We have revised our NII estimates by -5.3%/-5.2%/ -1.5%, PPOP by -7.3%/-7.2%/-5.1% and PAT by -3.5%/ -3.5%/-1.9% for FY19E/FY20E/FY21E respectively.  We have revised our P/ABV multiple from 2.3x to 1.9x. Applying it to the adjusted book value for September-20E of Rs 306 per share, we arrive at the fair value of Rs 570 (earlier Rs 630)  for the next 12 months.

In this briefing:

1. Titan Co Ltd (TTAN IN)
2. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

1. Titan Co Ltd (TTAN IN)

Titan Company Limited manufactures and sells watches, jewellery, eyewear, and other accessories and products in India and internationally. The company operates through four segments: Watches, Jewellery, Eyewear, and others. It is one of the few companies operating in organised jewellery retail industry of India. We visit stores & markets in Kochi (Kerela) and Chennai (Tamil Nadu), the biggest consumption markets to understand structural changes that have taken place in the industry, with an objective to tweak our revenue and margin estimates. We believe consensus might be underestimating growth from the jewellery segment which is the largest contributor with 81.60% of Sales as of FY2018. Our revenue estimates for FY19 and FY20 are 5.8% & 2.98% higher than consensus, primarily based on higher than expected market share gains from unorganised players. Our EBITDA margins for FY 19 & FY20 are 1% & 1.30% higher than consensus estimates primarily based on product mix which is in favour of studded jewellery and operating leverage as sales across stores pick up.  Our EPS for FY19 & FY20 is estimated at INR 18.60 and INR 24.26 per share which is higher than consensus by INR 2.47 and 4.05 per share for FY 19 and FY 20.  Based on an average forward multiple of 49x we arrive at a target price of INR 1187, representing a 30% potential return from current market price. 

2. State Assembly Results: Setting up a Direct Clash Between Indian Voters and Global Investors?

The  results of the state assembly elections especially of Rajasthan, Madhya Pradesh and Chhattisgarh reveal the growing dissatisfaction of the electorate with the economic policies of the ruling Bharatiya Janata Party (BJP). BJP policies such as demonetisation (which was initially hailed as a brilliant decision) and the manner of implementation of the Goods and Services Tax (GST) dealt a severe blow to employment-intensive sectors like agriculture and the micro and small industries. The BJP had also allowed the agrarian sector in India to bear the burden of deflation, causing widespread peasant disenchantment, which became visible in massive farmer demonstrations culminating in the recent gathering in Delhi. Global investors should be prepared for significant increases in government expenditure on rural welfare schemes and farm income support to alleviate rural distress. In the absence of surpluses from the Reserve Bank, the government would have to expand the fiscal deficit for such schemes. If, on the other hand, the newly appointed RBI governor transfers the realized portion of the central bank surplus (the contingency reserve) to the government, such expenditure will weaken the central bank’s balance sheet at a time of global volatility. For the global investors the India risk has only increased.

In this briefing:

1. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow
2. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much
3. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility
4. India Banks – The Roadmap Ahead
5. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

1. Mahindra & Mahindra Ltd- 2QFY19 – New Launches Cause Margin Pain, Benefits to Follow

• Mahindra & Mahindra (MM IN) reported 2QFY19 PAT of Rs 17,788 mn vs our estimate of Rs 15,240 mn. The revenues were 2.5% lower than estimated. EBITDA was Rs 18,493 mn as against our estimate of Rs 20,721 mn. EBITDA margins were  14.5% against our estimate of 15.8%.  Overall the performance was lower than our expectation.
• EBITDA margins were impacted due to higher raw material cost and higher launch cost related to Marazzo (7/8 seater utility vehicle). We expect the margins to remain under pressure for the 2HFY19E as the Company has lined up more new model launches.
• The shift in the festive season from 2Q to 3Q impacted the tractor sales volume in this quarter. M&M management expects the tractor industry to growth in the range of 12-14% YoY in FY19E where M&M is expected to grow at 12.5% YoY in FY19E.
• We have lowered EPS estimates for FY20E by 8%. Over FY18-21E, we expect revenue and PAT to grow at CAGR 14% and 13% respectively. We expect EBITDA margin to expand from 14.8% in FY18 to 15.5% in FY21E.
• Our EPS estimates for FY20E & 21E stand at Rs 47.3/- & Rs 53.7/- respectively. We have maintained the PE multiple of 17x with an EPS of Rs 47.2/- for the year ending September- 20E and valued its share in the subsidiaries at Rs 315/- to arrive at the fair value estimate of Rs 1,115/- for the next 12 months.

2. Bharat Heavy Electricals (BHEL IN): Don’t Expect the Share Buy-Back to Help Much

Bharat Heavy Electricals (BHEL IN) had announced a sizeable share buyback a couple of weeks ago. This buyback amounting to total Rs16.3 bn has opened yesterday, but we think that it is unlikely to help much. In the coming years, the Indian power distribution companies (DISCOMs) are likely to buy more power from renewable sources and the proposed changes in regulation will expedite the shift. In addition, resolution of power assets in distress continues to remain slow and new orders for Bharat Heavy Electricals (BHEL IN) which is already struggling with slow moving orders, remain sluggish. Another interesting development is shift in interest from company’s key customers. For example, NTPC Ltd (NTPC IN) is exploring acquisition opportunities much more than greenfield expansion. All of this is certainly bad news for the Bharat Heavy Electricals (BHEL IN) stock. While the PAT nos. are small in absolute terms and even a slight positive change will make valuations look attractive for the stock, this will not have a meaningful impact unless things improve structurally for the company.

3. India On Ground: Local Fund Managers Still Debate Valuations,OK with News Flow but Expect Volatility

Last few months have been stressful for domestic fund managers and more than the sudden market movement, much increased volatility even in large caps has led to more anxiety for them. When we speak with some of the local fund managers, we get the sense that, a) the earnings season was mixed though revenue expectations were largely met for most companies and the worry was miss on profitability for some, b) there is still not high level of comfort on valuations and though correction came as a relief, the cash levels were not sufficient to take advantage of the situation, c) melt down in mid/small caps affect them less than big correction in large caps and that is why sharp movement in names like Tata Consultancy Svcs (TCS IN) , Infosys Ltd (INFO IN) and Maruti Suzuki India (MSIL IN) had hurt them much more, not to mention the volatility in Yes Bank Ltd (YES IN) and Sun Pharmaceutical Indus (SUNP IN) which had different kind of issues.

Most of them also think that some of the recent controversies such as RBI vs. Govt were completely avoidable and reflect political mismanagement than anything else. BJP’s loss in recent assembly elections is also negative but this was not completely unexpected because the margin is really small and things could have gone either way. In fact, some of them also say that the main Opposition party, Congress has not been able to completely exploit the failures of BJP Govt politically and appointment of RBI Governor is just like any other Govt official and media was unnecessarily and excessively focused on it, much more than what is warranted fundamentally speaking. However, silver lining for them is that some other market heavyweights such as Reliance Industries (RIL IN) and Hindustan Unilever (HUVR IN) have been steady.

While there is not much clarity on direction for the markets in next six months, the expectation is that volatility in local markets is likely to continue in 1H CY19 for three primary reasons, a) both crude and INR will continue to play a key role in market movement and expectation is that they will remain volatile, b) how the global macro factors such as trade war and relative attractiveness of EMs will play their role is not clear, c) the political factors and related news flow will drive the markets and though people still expect BJP may return next year (albeit in a coalition and with reduced mandate post 2019 Lok Sabha elections), the comfort levels have dwindled compared to how people were looking at it six to eight months ago. Among the specific sectors for the market, the interest levels are higher in FMCG and BFSI. People don’t expect IT to do badly but optimism has come down and Autos have also been a disappointment over last few months.

4. India Banks – The Roadmap Ahead

With the Reserve Bank of India (RBI) now effectively run by the government, there are likely to be discernable red flags ahead. We must expect that banks like State Bank Of India (SBIN IN) and others will overtly act as providers of liquidity. This will be both to struggling companies but also cash-strapped non-banking finance companies (NBFCs). In quarterly data this should show up in bank-specific figures, monetary numbers but also in corporate debt levels. It will be interesting to see if debt levels rise more for fragile indebted companies than others. Defaults should rise as well. This is because companies now realize that the government is running credit creation to support debtors, and will find it unjust to service a loan when others are not being penalized for default; at the margin they will choose not to pay. This goes to the well-known situation that occurred in Thailand after the 1997 crisis where the term was coined ‘can pay, won’t pay’ for these types of debtors.

5. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

Contrary to the perception that the rising adoption of socially responsible investment practices has caused Big Tobacco to be shunned by portfolio managers, our shareholding analysis shows that institutional holding in most of these ‘sin’ stocks has increased in the last 4 and 8 quarters.

Nevertheless, Big Tobacco suffered a pounding in 2018. Investors had bought into tobacco premising reduced risk products (Eg: e-cigarettes, Heat Not Burn products) would reduce regulatory risk and reverse decades of sales decline. As it turned out, regulators frowned at the popularity of vaping amongst teens in the US, calling out companies for baiting youngsters into long-term smoking habits. Regulators also told off companies for marketing e-cigarettes and HNBs as healthier options, as tobacco still kills.

Ethical portfolios with negative screens (for example, ones that will not invest in tobacco stocks) have underperformed in the long-term past. There is a growing tribe of funds committed to responsible investing with positive ESG screens. For such funds, we present in this insight a framework for analyzing the sector from an ESG perspective. A deep dive into ITC Ltd (ITC IN), the only cigarette major to turn in a positive performance this year, vindicates, in our view, its efforts to materially de-risk its asset and revenue profile, coupled with very high levels of commitment towards community development.